601 F. Supp. 685 (S.D.N.Y. 1985)
In a four count indictment (the "Indictment") filed on August 30, 1984, defendant Thomas C. Reed ("Reed") was charged by a grand jury in the Southern District of New York (the "Grand Jury") with criminal violations in connection with the purchase and sale of stock call options of Amax, Inc. ("Amax"), during the winter of 1981. Specifically, Reed is charged in Count One of the Indictment with securities fraud in violation of sections 10(b) and 32 of the Securities Exchange Act of 1934, (the "Exchange Act"), 15 U.S.C. §§ 78j, 78ff, and Rule 10b-5, 17 C.F.R. § 240.10b-5.1 Based on the same allegations, Count Two charges that Reed's conduct constituted wire fraud in violation of 18 U.S.C. §§ 2, 1343.2 In Count Three of the Indictment it is alleged that Reed lied in a deposition in which he testified in connection with a civil action for securities fraud brought by persons who sold Amax options at the time that, inter alios, Reed traded. Reed is thus charged in Count Three with perjury, in violation of 18 U.S.C. § 1623.3 Count Four of the Indictment charges that Reed created and used fraudulent documentation to obstruct justice in the civil proceeding, in violation of 18 U.S.C. § 1503.4 Reed now moves, pursuant to Rule 12(b), Fed.R.Crim.P., to dismiss the Indictment, on the grounds that Counts One and Two fail to allege criminal offenses, and that venue for Counts Three and Four does not properly lie in the Southern District of New York. For the reasons hereinafter stated, Reed's motion is granted in part and denied in part, and Counts Three and Four of the Indictment are dismissed.
The Court assumes, as it must, the truth of the facts as alleged in the Indictment and may not consider defendant's contrary assertions of fact. See Boyce Motor Lines, Inc. v. United States, 342 U.S. 337, 343 n. 16, 72 S.Ct. 329, 332 n. 16, 96 L.Ed. 367 (1952); United States v. Pacione, 738 F.2d 567, 568 (2d Cir.1984); United States v. Von Barta, 635 F.2d 999, 1002 (2d Cir.1980), cert. denied, 450 U.S. 998, 101 S.Ct. 1703, 68 L.Ed.2d 199 (1981).
The gravamen of the Government's case against Reed, as charged in the Indictment, is the allegation that, from on or about January 26, 1981, up to and including March 18, 1981, Reed engaged in a fraudulent scheme designed to enrich himself, as well as his friends and associates, by trading in the securities of Amax while he was in possession of material, nonpublic, confidential information. Thereafter, it is alleged, Reed fraudulently and perjuriously attempted to disguise his transgressions. Specifically, it is asserted, that as part of this fraudulent scheme: (a) Reed obtained nonpublic, confidential information concerning the proposed merger of Amax into Standard Oil Company of California ("Socal") from his father, Gordon W. Reed; (b) Reed misappropriated this information and engaged in the purchase and sale of Amax stock call options without first disclosing the confidential information in his possession, in breach of a duty arising from a fiduciary and other relationship of trust and confidence owed by Reed directly to his father, to Amax and to the shareholders of Amax; and (c) Reed thereafter both gave perjurious testimony in a deposition and submitted fraudulent and misleading documentation during the course of discovery proceedings in connection with a civil action brought by options traders against Reed and others based on the sale of Amax call options during the period at issue herein.
At all times relevant to the Indictment, Reed was the president of Quaker Hill Development Corporation ("QHDC") in San Rafael, California. QHDC is a land development company wholly owned by Reed and his family. Reed's father was at this time a member of the Board of Directors of Amax, and chairman of the Amax Petroleum Corporation, a wholly owned subsidiary of Amax. At all times relevant to this action, Amax was a publicly-held corporation engaged in the exploration for and the mining and refining of ores and minerals. Amax stock is traded on the New York Stock Exchange and other exchanges.
During this time, Socal was a publicly-held corporation engaged in world-wide, integrated petroleum operations. Since 1975, Socal has owned approximately twenty percent (20%) of Amax common stock. From in or about September 1980 up to and including March 4, 1981, Amax was engaged in nonpublic, confidential discussions concerning a proposed merger of Amax into Socal. Specifically, on January 26, 1981, the chairman of the Board of Directors of Amax met with the chairman of the Socal Board of Directors to discuss the possibility of a merger of Amax into Socal. These discussions were secret and confidential. Four days later, Reed purchased one hundred "March 45" Amax stock call options in the name of QHDC.5 This purchase was made shortly after Reed had participated in a telephone conversation with his father. On the next business day, February 2, 1981, Reed purchased an additional four hundred "March 50" Amax call options in the name of QHDC. On the following day, Reed telephoned Ian K. MacGregor, a member of the Amax Board of Directors in an attempt to obtain further information concerning the likelihood of a merger between Amax and Socal.
The merger discussions continued through February and into early March 1981. On February 25, 1981, the Socal Board of Directors approved in principle a merger proposal pursuant to which Socal offered to acquire all outstanding Amax common stock in exchange for cash and Socal securities worth approximately $78.50 per Amax share. This offer was communicated in confidence to the chairman of the Board of Directors of Amax for consideration by the Amax Board. Information concerning the Socal offer was then disseminated to the members of the Amax Board of Directors, including Gordon Reed. At that time Gordon Reed was vacationing on the Island of Barbados.
On March 2, 1981, and again on March 4, 1981, after Gordon Reed had received news of the Socal offer, Reed spoke by telephone with his father. During those conversations, Reed received nonpublic, confidential information relating to the Socal merger proposal. This information was provided to Reed in confidence and with the firm expectation that Reed would respect this confidence. The relationship between Reed and his father was particularly close; the two men frequently discussed business affairs in the expectation that Reed would keep his father's confidences.6
This time, however, Gordon Reed's expectations of confidence were to be disappointed. On March 4, 1981, at 9:42 a.m. (Eastern Standard Time), immediately after the completion of a telephone conversation with his father, Reed placed a series of phone calls to the brokerage firm, Dean Witter Reynolds, Inc., in San Rafael, California, in an attempt to purchase Amax securities while he was in possession of nonpublic, confidential information concerning the Socal merger proposal. Later that morning, after contacting his securities broker, Reed purchased five hundred "March 50" Amax call options on the American Stock Exchange in New York City, at a total cost of $3,346.76.
On the following day, at a special meeting, the Amax Board of Directors considered the Socal merger proposal and determined not to support that offer. This decision of the Amax Board and the details of the Socal merger proposal were publicly disclosed for the first time on that afternoon.
On March 4, 1981, prior to the special meeting of the Amax Board of Directors and to the public disclosure of the Socal merger proposal, Amax common stock was trading at approximately thirty-eight dollars ($38.00) per share. On that same day, a contract for Amax "March 45" call options was trading at twelve and one half cents ($0.125) per share, and a contract for Amax "March 50" call options was trading at six and one quarter cents ($0.0625) per share. On March 6, 1981, the day following the public announcement of the Socal merger proposal, the price of Amax common stock increased from an opening price of thirty-eight dollars ($38.00) to fifty-seven ($57.00) per share. Similarly, the price of Amax "March 45" call options increased from twelve and one half cents ($0.125) to twelve dollars and twenty five cents ($12.25) per share, while the price of Amax "March 50" call options jumped from six and one quarter cents ($0.0625) to eight dollars and seventy-five cents ($8.75) per share.
On or about March 6, 1981, in an effort to capitalize on the salutary effect of the disclosures of the Socal proposal on the price of Amax securities, Reed sold the five-hundred "March 50" call options that he had purchased two days earlier. Reed's profit from this transaction amounted to approximately four hundred thirty-one thousand dollars ($431,000.00).7
Subsequently, on March 10, 1981, O'Connor & Associates, an options trading firm, commenced a civil class action against eighteen defendants, including Reed, in the United States District Court for the Southern District of New York, O'Connor & Associates et al. v. Dean Witter Reynolds, Inc., et al., 81 Civ. 1354(MEL). (the "O'Connor litigation"). Plaintiffs in that action had sold Amax call options during the period from February 23, 1981 to March 5, 1981.8 In connection with that action, Reed testified in a deposition in San Francisco, California, on April 21-22, 1982.9 The transcript of that deposition was thereafter filed with the United States District Court for the Southern District of New York. During this deposition, Reed gave perjurious testimony concerning the circumstances surrounding his transactions involving Amax call options. In the course of discovery proceedings in the O'Connor litigation, Reed also presented and relied upon false and misleading documentation, i.e., handwritten notes that he had created in order to disguise the fact that he had engaged in such transactions while in possession of nonpublic, confidential information.
Based on these allegations, the Grand Jury charged Reed with four criminal statutory violations. Count One alleges that Reed's March 4, 1981 purchase of five hundred "March 50" Amax call options operated as a fraud in violation of section 10(b) of the Exchange Act, and Rule 10b-5 thereunder.10 Count Two is premised on Reed's telephonic conversation with the Dean Witter Reynolds offices in San Rafael, California and New York City, and charges that Reed's use of the telephone in connection with the disputed Amax options transactions constituted wire fraud in violation of 18 U.S.C. § 1343.11 See Letter of Assistant United States Attorney, Paul L. Shechtman, Esq. to Edward M. Shaw, Esq. at 3 (Sept. 27, 1984) (the "Shechtman Letter"), contained as Exhibit B to the Reed Memo.12
The latter two counts of the Indictment involve the post-trading aspects of the Government's case, in particular, the discovery phase of the O'Connor litigation. Count Three asserts that Reed committed perjury during his deposition in the O'Connor litigation in violation of 18 U.S.C. § 1623.13 The last count accuses Reed of obstruction of justice by his "creating and using false and misleading documentation, to wit, handwritten notes ... to disguise the fact that he had made such purchases while in possession of unlawfully obtained non-public confidential information," in violation of 18 U.S.C. § 1503.14 Indictment at ¶ 15.
On October 17, 1984, Reed filed the instant motion to dismiss the Indictment in its entirety. At the outset, Reed expressly denied that he received any nonpublic, confidential information concerning the Socal merger proposal from his father or any other source prior to his March 4, 1981 securities transactions. Moreover, he argues that Counts One and Two should be dismissed because they each fail to allege acts that constitute a criminal violation by Reed. Even if the remaining two counts sufficiently allege criminal offenses, Reed continues, those counts should also be dismissed because venue for prosecutions for the offenses alleged in those counts does not properly lie in this district.
With respect to Counts One and Two, Reed argues that under the instant circumstances and consistent with the express language of the Indictment, the sole theory upon which guilt can rest is that Reed misappropriated "inside" information from his father for the purpose of engaging in highly profitable securities transactions. Reed asserts, and the Government agrees, that he cannot properly be charged as a "tippee" who illegally traded on the basis of nonpublic confidential information received from a corporate insider.15 Pursuant to the recent decision of the Supreme Court in Dirks v. SEC, 463 U.S. 646, 103 S.Ct. 3255, 77 L.Ed.2d 911 (1983), the argument proceeds, an essential element of tippee liability under Rule 10b-5 is proof that the tipping insider disclosed the confidential information with the knowledge or expectation that the tippee would trade on the information, and, thus, with the intent to defraud the securities holders of the insider's company. However, the Indictment does not allege the existence of such a state of mind on the part of Gordon Reed, and the Government has formally acknowledged that it will not endeavor to establish that Reed's father was possessed of such fraudulent intent. See Shechtman Letter at 2.
Reed argues that, given this state of affairs, the survival of Counts One and Two rises and falls with an entirely different theory of liability. Specifically, the Indictment alleges that Reed stood in a fiduciary or other relationship of trust and confidence with his father, that in breach of their relationship, Reed misappropriated the information about the Socal merger proposal that he had learned from his father, and that, as a result, Reed's trades on March 4, 1981 constituted securities and wire fraud. See Indictment at ¶ 7. In his motion papers, Reed asserts that this "misappropriation" theory must fail for two independent reasons. First, he urges, the Indictment lacks the factual allegations necessary to establish the existence of a fiduciary relationship between Reed and his father. The mere assertion in paragraph 4 of the Indictment that "Gordon W. Reed and Thomas C. Reed had a special relationship of trust and confidence and frequently discussed business affairs in the expectation that Thomas C. Reed would keep his father's confidences" is insufficient, Reed contends, to sustain the Government's allegation that Reed was the confidant of his father. A second deficiency in Counts One and Two, Reed maintains, is that those counts do not allege and would not support a claim that defendant's conduct resulted in some legally cognizable injury or potential injury to Gordon Reed.
Turning to the remaining counts of the Indictment, Reed denies that he had testified falsely under oath or that he submitted fraudulent and misleading documents during the course of discovery proceedings in the O'Connor litigation. However, Reed continues, even if the charges contained in Counts Three and Four are accurate, he may not be prosecuted in the Southern District of New York for the crimes alleged. According to Reed, there exists binding Second Circuit authority to the effect that the proper venue for prosecutions for perjury and obstruction of justice is not the district in which the underlying judicial proceeding (the "target proceeding") is pending. Instead, Reed maintains, precedent has established that venue for such prosecutions lies only in the district in which the alleged criminal acts took place. Since both the deposition testimony and submission of documents at issue in the instant case occurred beyond the confines of this district, Reed concludes, there is no basis for venue in the Southern District of New York for prosecution under Counts Three and Four.
In response to Reed's motion, the Government argues that the Indictment should not be dismissed and that Reed's motion should be denied because Counts One and Two properly allege acts constituting securities fraud and wire fraud and because venue properly lies in this district for a prosecution under Counts Three and Four. With respect to the first two counts of the Indictment, the Government, joined by the SEC,16 asserts that Reed engaged in criminally fraudulent conduct by misappropriating nonpublic, confidential information from his father, in breach of the Reeds' relationship of trust and confidence. Such conduct, the Government charges, violates the federal securities and wire fraud statutes, and is not protected from prosecution by the Supreme Court's decision in Dirks v. SEC, supra, 103 S.Ct. 3255. "Of course, none of these charges have been established by evidence, but at this stage of the proceedings the indictment must be tested by its sufficiency to charge an offense." United States v. Sampson, 371 U.S. 75, 78-79, 83 S.Ct. 173, 174-175, 9 L.Ed.2d 136 (1962). Moreover, it is fundamental that an indictment must set forth the elements of the offense sought to be charged, and that an indictment that does not state a crime cannot be sustained. See e.g., Walker v. United States, 342 F.2d 22, 26 (5th Cir.), cert. denied, 382 U.S. 859, 86 S.Ct. 117, 15 L.Ed.2d 97 (1965); Johnson v. United States, 206 F.2d 806, 808 (9th Cir.1953).
In connection with Count Three, the Government contends that under the express terms of the federal perjury statute venue may lie in the Southern District of New York inasmuch as Reed's alleged prevarications occurred during a proceeding "ancillary to" a civil action in this district. See 18 U.S.C. § 1623(a). Similarly, the Government insists, the crime of obstruction of justice, with which Reed is charged in Count Four, may be prosecuted in this district because the relevant case law, legislative history, and public policy considerations permit such prosecutions in the district in which the administration of justice was intended to be impeded.
The instant case presents an issue of first impression, this Court's resolution of which the Government contends significantly may affect future litigation under the securities laws.17 Against this background, and at the risk of belaboring what may by now have become doctrinally obvious, the Court embarks upon a brief review of the recent additions to the relevant legal landscape in order to more carefully set the juridical context of the instant case. With the guidance of such precedent, the Court turns to address the various contentions of the parties and to assess the legal sufficiency of the allegations and charges presented by the Indictment.
The parties correctly perceive that the sufficiency vel non of Counts One and Two depends upon this Court's assessment of the legal consequences of the relationship between Reed and his father as alleged in the Indictment. Both sides acknowledge that, as the Supreme Court held in Chiarella v. United States, 445 U.S. 222, 100 S.Ct. 1108, 63 L.Ed.2d 348 (1980), the mere possession of nonpublic, confidential market information does not bring with it a corresponding duty to publicly disclose that information or to abstain from trading on the basis of such select knowledge.18 See id. at 234, 100 S.Ct. at 1117. Rather, the duty to "disclose or abstain" arises only from a relationship of trust and confidence either between the parties to a market transaction or between the trading party and the source of that information.
The defendant in Chiarella was a "markup man" employed by a financial printer. On the basis of information contained in various announcements of corporate takeover bids that his employer was hired to print, the defendant was able to deduce the names of the target companies of several bids before the final printing and dissemination of the announcements. Without disclosing this knowledge, he purchased stock in the target companies and sold the shares immediately after the takeover attempts were disclosed publicly. For his efforts, the defendant found himself with substantial —albeit short lived—trading gains, as well as a seventeen count conviction for violations of section 10(b) and Rule 10b-5. Neither was to survive — the defendant was forced to disgorge his profits to the sellers of the shares, and the Supreme Court reversed his conviction. The Court explained that when an allegation of fraud is based upon nondisclosure, there can be no conviction absent a duty on the part of the defendant to speak. "And the duty to disclose arises when one party has information `that the other [party] is entitled to know because of a fiduciary or other similar relation of trust and confidence between them.'" Id. at 228, 100 S.Ct. at 1114 (quoting Restatement (Second) of Torts § 551(2)(a) (1976)) (brackets in original).
Applying these principles to the case confronting it, the Chiarella court held that the defendant had been under no duty to disclose the information concerning the takeover plans of the acquiring companies. He was not a corporate insider, and had received no confidential information from the target companies. Moreover, the Court explained, no such duty arose from the defendant's relationship with the sellers of the target companies' securities because the defendant had had no prior dealings with them, was not their agent or fiduciary, and was not a person in whom those sellers had placed their trust and confidence. The Court concluded:
We cannot affirm petitioner's conviction without recognizing a general duty between all participants in market transactions to forgo actions based on material, nonpublic information. Formulation of such a broad duty, which departs radically from the established doctrine that duty arises from a specific relationship between two parties, see n. 9, supra, should not be undertaken absent some explicit evidence of congressional intent.
....
.... Section 10(b) is aptly described as a catchall provision, but what it catches must be fraud. When an allegation of fraud is based upon nondisclosure, there can be no fraud absent a duty to speak. We hold that a duty to disclose under § 10(b) does not arise from the mere possession of nonpublic market information.
Id., at 233-35, 100 S.Ct. at 1117-18.19
More recently, in Dirks v. SEC, supra, 103 S.Ct. 3255, the Supreme Court had further occasion to address and refine the source and scope of tippee liability under the section 10(b) and Rule 10b-5.20 In Dirks, the Court again rejected the notion that a general duty attaches to anyone who knowingly receives nonpublic material information from an insider to disclose that information before trading. Instead, Justice Powell reaffirmed his holding for the Court in Chiarella that the mere possession of nonpublic, confidential information does not give rise to a duty to disclose or abstain; only a specific relationship of trust and confidence between the parties creates such a duty.21 See Dirks v. SEC, supra, 103 S.Ct. at 3262 n. 15; Moss v. Morgan Stanley Inc., 719 F.2d 5, 12 (2d Cir.1983), cert. denied, ___ U.S. ___, 104 S.Ct. 1280, 79 L.Ed.2d 684 (1984); Walton v. Morgan Stanley & Co., Inc., 623 F.2d 796, 799 (2d Cir.1980).
Because this requirement of a specific relationship between the shareholders and the individual trading on inside information has created analytical difficulties for the SEC and the courts in policing tippees who trade on inside information, the Court expressly delineated the circumstances under which a ban on tippee trading attaches. The Court acknowledged that there must be some limits on tippee trading, else insiders might escape the constraints of their fiduciary duty not to exploit corporate information for personal gain by passing nonpublic, confidential information on to outsiders for the same improper purpose. Consistent with the precept that a relationship of trust and confidence is at the fulcrum of liability under section 10(b), the Court concluded that the tippee's duty to disclose or abstain from trading is derivative of the insider's duty. Justice Powell explained:
Thus, some tippees must assume an insider's duty to the shareholders not because they receive inside information, but rather because it has been made available to them improperly. And for Rule 10b-5 purposes, the insider's disclosure is improper only where it would violate his Cady, Roberts duty. Thus a tippee assumes a fiduciary duty to the shareholders of a corporation not to trade on material nonpublic information only when the insider has breached his fiduciary duty to the shareholders by disclosing the information to the tippee and the tippee knows or should know that there has been a breach.
Id. at 3264 (footnote omitted).
As a result of the secondary nature of tippee liability, a tippee may be under a duty to disclose or abstain only when the information on which he relied was tipped to him by an insider in breach of the insider's fiduciary duty. Whether a particular disclosure constitutes such a breach, the Court concluded, depends in large part on the purpose of the disclosure. In the words of Justice Powell:
the test is whether the insider personally will benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty to stockholders. And absent a breach by the insider, there is no derivative breach....
.... [T]o determine whether the disclosure itself "deceive[s], manipulate[s], or defraud[s]" shareholders, Aaron v. SEC, 446 U.S. 680, 686, 100 S.Ct. 1945, 1950, 64 L.Ed.2d 611 (1980), the initial inquiry is whether there has been a breach of duty by the insider. This requires courts to focus on objective criteria, i.e., whether the insider receives a direct or indirect personal benefit from the disclosure, such as a pecuniary gain or reputational benefit that will translate into future earnings.
Id. at 3265-66 (footnote omitted) (brackets in original).22
In the instant case, the Indictment does not allege and the Government does not maintain that Gordon Reed disclosed any information concerning the Socal offer with an eye towards receiving a direct or indirect personal benefit from such disclosure. In particular, it is nowhere charged that Gordon Reed revealed to defendant nonpublic, confidential information concerning the Socal offer out of a desire for "pecuniary gain or a reputational benefit that will translate into future earnings." Dirks v. SEC, supra, 103 S.Ct. at 3266. On the contrary, the Government has continually depicted Gordon Reed as the victim of his son's connivance, having mistakenly relied on defendant's confidence and on the expectation that the son would not trade on the basis of the father's disclosures. See, e.g., Oral Argument Transcript at 24. Thus, the Government had not charged and does not here contend that Gordon Reed breached his Cady, Roberts duty to Amax and its shareholders not to use inside information for personal advantage. See Cady, Roberts & Co., supra, 40 S.E.C. at 912 n. 15. In the absence of such a breach by the insider, defendant's father, the Government concedes that there can be no derivative "tippee" liability by Reed, and defendant is not so accused.23
From the perspective of public policy, the constellation of principles enunciated in Chiarella and Dirks present this Court with a troubling anomaly. As applied, those principles indicate that an individual who receives from a corporate insider nonpublic, confidential information that is likely to affect the value of a corporation's securities will be liable if the insider made the disclosure out of a desire for personal material gain but not if the insider acted with a more benign purpose.24 This conclusion, however, hardly ends the present inquiry. After the Supreme Court's decisions in Chiarella and Dirks, it is no longer open for the Government to pursue Reed for fraudulent nondisclosure on a theory of tippee liability. However, those cases raise no obstacle to the theory of liability propounded in the Indictment. Specifically, the Indictment alleges that Reed misappropriated from his father nonpublic, confidential information concerning the Socal merger proposal. Relying on the holding in United States v. Newman, 664 F.2d 12 (2d Cir.1981), cert. denied, ___ U.S. ___, 104 S.Ct. 193, 78 L.Ed.2d 170 (1983), and its reaffirmation in SEC v. Materia, 745 F.2d 197 (2d Cir.1984), the Government argues that Reed committed securities and wire fraud when he "misappropriate[d] nonpublic information in breach of a fiduciary duty and trade[d] on that information to his own advantage." SEC v. Materia, supra, at 203.
This theory of liability attempts to impose criminal culpability for improper trading on "outsiders," i.e., persons who lack a direct fiduciary relationship with a corporation or its shareholders. See generally Note, Outsider Trading After Dirks v. SEC, 18 Ga.L.Rev. 593 (1984); Langevoort, Insider Trading and the Fiduciary Principle: A Post-Chiarella Restatement ("The Fiduciary Principle"), 70 Cal.L.Rev. 1, 44-53 (1982). Under this theory it is not argued that defendant breached some obligation to disclose material nonpublic information to those with whom he trades, or to the public-at-large. Rather, the focus of analysis under this approach is on the source of the information. See Langevoort, The Fiduciary Principle, supra, 70 Cal.L. Rev. at 46. Stripped to its essentials, outsider trading liability is premised on the common law principle that when a fiduciary profits from confidential information that he had received because of his fiduciary status, he breaches a legal duty to the person or entity that entrusted him with the information. The misappropriation of secret information for personal aggrandizement in breach of such a relationship constitutes fraud. See e.g., United States v. Newman, supra, 664 F.2d at 18. The origins of this approach can be traced to the law of restitution. A person who receives confidential information from another and misappropriates it for personal benefit is deemed to hold the proceeds of the misappropriation in a constructive trust for the benefit of the entrusting party. The misappropriator thus becomes the trustee ex maleficio, or quasi-fiduciary, of the entrustor. See Langevoort, The Fiduciary Principle, supra, 70 Cal.L.Rev. at 30-31 & n. 121. In the context of the securities laws, it does not matter for purposes of assessing liability whether the recipient of the information is actually trading in the securities issued by the source of the information. Rather, the duty is breached by the misappropriation and resulting profit, and a constructive trust attaches.25
In United States v. Newman, supra, 664 F.2d 12, the Second Circuit decided in the affirmative the issue left open in Chiarella as to whether criminal liability for securities fraud can be premised upon the fiduciary duty owed to an acquiring corporation by virtue of one's position as an employee of a firm retained by that corporation. The defendant in Newman was a securities trader and manager of the over-the-counter trading department of a New York brokerage firm. He had obtained confidential information concerning proposed corporate mergers and acquisitions from the employees of certain investment banking firms. The employees had misappropriated this information, which had been entrusted to their employers by corporate clients, and surreptitiously conveyed it to Newman. Newman, in turn, passed the information along to two foreign confederates. The three conspirators then constructed and executed an elaborate scheme for purchasing the stock of companies that were merger and takeover targets of the subject investment banking firms. By making such purchases prior to the announcement of the various corporate acquisitions and the accompanying rise in the market price of the target company's securities, the conspirators were able subsequently to sell the stock at prices well higher than the prices they had paid for the same securities. As a result, Newman and his co-conspirators reaped substantial profits, which they shared with the employees of the investment banking firms. All five men were indicted for securities and mail fraud. In upholding the legal sufficiency of this indictment, a divided panel of the Second Circuit held that the defendants' misappropriation of confidential information entrusted to the investment bankers constituted the requisite element of fraud under Rule 10b-5 as well as a breach of duty to both the investment banking firms and those firms' clients. The court explained that "[b]y sullying the reputations of the [investment banking firms] as safe repositories of client confidences, [Newman] and his cohorts defrauded those employers as surely as if they took their money." Id. at 17 (citations omitted). Moreover, the court continued, the defendants also wronged the clients of the investment banking firms, "whose takeover plans were keyed to target company stock prices fixed by market forces, not artificially inflated through purchases by purloiners of confidential information." Id.26
In Materia, the Second Circuit reaffirmed its holding in Newman "that one who misappropriates nonpublic information in breach of a fiduciary duty and trades on that information to his own advantage violates Section 10(b) and Rule 10b-5." SEC v. Materia, supra, at 203 (footnote omitted). The court rejected as contrary to its holding in Newman the defendant's argument that, inasmuch as he had no duty of disclosure to those with whom he had traded, he could not be held to have violated section 10(b) and Rule 10b-5. The court instructed that ancillary issues such as standing and whether the defendant had breached a duty to a particular plaintiff arise only in private civil actions for securities fraud. They are not germane in enforcement actions brought by the SEC. Rather, as the court had previously held in Newman, section 10(b) and Rule 10b-5 do not require the perpetration of a fraud on a particular buyer or seller of securities. It is sufficient that the defendant's conduct "operat[ed] ... as a fraud or deceit upon any person, in connection with the purchase or sale of any security." Rule 10b-5. See also SEC v. Materia, supra, 201-203; United States v. Newman, supra, 664 F.2d at 18-19.
The defendant in Materia was employed as a "copyholder" by a financial printer. Despite extensive efforts by the employer and its clients to keep confidential certain information concerning proposed tender offers,27 the defendant was able to derive the identities and purchase the securities of several tender offer targets. Soon after the public announcement of the planned corporate acquisitions and the concomitant rise in the market price of the securities, the defendant sold his holdings at substantial gains. Shortly thereafter, the SEC filed an enforcement action, charging that the defendant had violated and was about to violate section 10(b) and 14(e) of the Exchange Act and Rule 10b-5 and 14e-3 thereunder. The complaint was premised upon the SEC's allegations that the defendant had traded in securities of the tender offer targets on the basis of material nonpublic information that he had misappropriated from his employer and its clients. Following a nonjury trial, the district court held that the defendant's conduct violated the antifraud provisions of the federal securities laws as charged. On appeal, the defendant did not contest the district court's finding that he had misappropriated confidential information from his employer and traded on that information to his advantage. Instead he argued that such activity does not violate the securities laws, an argument that the court held directly controverted its holding in Newman. See SEC v. Materia, supra, at 201. The court explained:
Materia "misappropriated — stole to put it bluntly—valuable nonpublic information entrusted to him in the utmost confidence." United States v. Chiarella, 445 U.S. 222, 245 [100 S.Ct. 1108, 1123, 63 L.Ed.2d 348] (1980) (Burger, C.J., dissenting). We hold that such activity falls squarely within the "fraud or deceit" language of the Rule. Legislative history to the Securities Exchange Act of 1934 makes clear that the antifraud provision was intended to be broad in scope, encompassing all "manipulative and deceptive practices which have been demonstrated to fulfill no useful function." S.Rep. No. 792, 73d Cong., 2d Sess., 6 (1934). This language negates the suggestion that the provision was aimed solely at the eradication of fraudulent trading by corporate insiders. Against this expansive construction of "fraud or deceit," Materia's theft of information was indeed as fraudulent as if he had converted corporate funds for his personal benefit.
Id. at 201-202.
The Court similarly rejected the defendant's argument that his employer had not been injured by the defendant's misappropriation of client confidences. The court opined that
[a]mong a financial printer's most valuable assets is its reputation as a safe repository for client secrets. By purloining and trading on confidences entrusted to Bowne, it cannot be gainsaid that Materia undermined his employer's integrity. See Newman, supra, at 17. Accordingly, we are driven to the conclusion that, by his misappropriation of material nonpublic information, Materia perpetrated a fraud upon Bowne.
Id. at 202 (footnote omitted).
In expanding upon the conception of outsider-misappropriation liability under the securities laws that was marginally addressed in Chiarella and Dirks, the Second Circuit in Newman and Materia established a binary principle of analysis. On the one hand, the cases reveal that those who misappropriate nonpublic, confidential information that they then use to engage in securities trades may be liable under section 10(b) and Rule 10b-5 even if they owed no duty of disclosure to the sellers of the securities involved.28 On the other hand, however, the cases have conditioned such liability on the existence of, at least, a duty of fidelity and confidentiality to some person or persons, which duty is rooted in a fiduciary or other relationship of trust or confidence between the misappropriator and the person or entity to whom the duty is owed.29
As the foregoing cases require, and the parties readily concede, the focus of this Court's inquiry must settle upon the question of whether Reed and his father enjoyed a relationship of trust and confidence. According to the Government, this relationship both inspired the alleged disclosure by Gordon Reed and governed the uses that defendant legally might have made of such information. Absent proof of the existence of such a relationship and corresponding duty, Reed may not be held criminally liable under the "misappropriation" theory advanced in the Indictment. Similarly, inasmuch as Reed's alleged violation of the wire fraud act also requires proof of a fraudulent breach of fiduciary duty, failure by the Government to establish the special relationship alleged will prove fatal to both Counts One and Two. See, e.g., United States v. Weiss, 752 F.2d 777, 783 (2d Cir.1985); United States v. Siegel, 717 F.2d 9 (2d Cir.1983) (mail fraud statute is violated when fiduciary fails to disclose material information that he is under a duty to disclose to another under circumstances in which the non-disclosure could or does result in harm to another); United States v. Newman, supra, 664 F.2d 12 (same requirement for both securities fraud and mail fraud liability); United States v. Bronston, 658 F.2d 920 (2d Cir. 1981), cert. denied, 456 U.S. 915, 102 S.Ct. 1769, 72 L.Ed.2d 174 (1982) (mail fraud); United States v. Von Barta, supra, 635 F.2d 999 (mail and wire fraud).
The Court notes at the outset of this undertaking that the concept of "confidential relationship," born and reared in equity, is by nature flexible and defiant of precise definition:
Courts of equity have carefully refrained from defining the particular instances of fiduciary relations in such a manner that other and perhaps new cases might be excluded, and have refused to set any bounds to the circumstances out of which a fiduciary relation may spring.
36A C.J.S. Fiduciary at 385 (1961) (footnote omitted). See also Bogert, Confidential Relations and Unenforcible Express Trusts, ("Confidential Relations") 13 Cornell L.Q. 237 (1928); 3 J.N. Pomeroy, Equity Jurisprudence § 956, at 792 (5th ed. 1941). There are, then, "no hard and fast rules for determining whether a confidential relationship exists. Roberts v. Sears, Roebuck & Co., 573 F.2d 976, 983 (7th Cir.), cert. denied, 439 U.S. 860, 99 S.Ct. 179, 58 L.Ed.2d 168 (1978). See also G.G. Bogert, The Law of Trusts and Trustees ("Bogert") § 482 (Rev. 2d ed. 1978).
Despite the lack of universality and uniformity of practice among courts and commentators in their analysis of the scope and effect of the legal constructs, "fiduciary relationship" and "confidential relationship,"30 certain associations have emerged as inherently fiduciary in nature. See, e.g., Coffee, From Tort to Crime: Some Reflections on the Criminalization of Fiduciary Breaches and the Problematic Line Between Law and Ethics ("From Tort to Crime"), 19 Am.Crim.L.Rev. 117, 150-51 (1981); Bogert supra, §§ 481-82; Bogert, Confidential Relations, supra, 13 Cornell L.Q. at 248.
Among these inherently judicial relationships are those of: executors, administrators, guardians, trustees, attorneys, and senior corporate officials. See Coffee, From Tort to Crime, supra, 19 Am.Crim. L.Rev. at 150; Scott, The Fiduciary Principle, 37 Cal.L.Rev. 539, 541 (1949). "Still, this list is far from exhaustive, and the common law has in fact always defined the term with deliberate imprecision and perhaps suprising expansiveness." Coffee, From Tort to Crime, supra, 19 Am.Crim. L.Rev. at 150. There are many other circumstances in which there is at least a great intimacy, confidentiality, reliance and superiority of influence as those enumerated but in which the law has no special designation for the relationship between the parties. Such relationships commonly are called "confidential relationships," and have enjoyed the same protections that chancery has extended to inherently fiduciary relations. See, e.g., Bogert, supra, § 482 at 281.31
In the instant case, the Government concedes that the relationship between Reed and father was not inherently fiduciary, but argues instead that such relationship posses sufficient characteristics of a confidential relationship to subject Reed's conduct to the strictures of the securities laws. The Government asserts that Reed was possessed of his father's absolute confidence and purported to act with his father's interest in mind. In the Government's view the intimacy of interaction between Reed and his father and their repeated disclosure of confidences involving the affairs of business and commerce rendered their relationship "instinct with obligation." Government's Memorandum In Opposition to Thomas C. Reed's Motion to Dismiss ("Government's Memo."), at 9. (S.D.N.Y. Nov. 13, 1984). In reliance on this aura of confidentiality, the Government asserts, Gordon Reed relaxed the vigilence that he would have otherwise have exercised and informed Reed of the Socal merger proposal, despite the precautions normally attendant in such situations. Accordingly, the argument continues, when Reed traded on the basis of the inside information he had allegedly learned from father, he abused the confidence that his father had reposed in him, and thereby breached a duty owed to his father, in violation of the securities and wire fraud statutes. Id. at 10.
In opposition and response, Reed argues that the Indictment is deficient in two independent respects. First, Reed contends the Indictment fails to allege facts essential to a finding that Reed and his father were bound by a special relationship of trust and confidence, the breach of which violated the federal securities and wire fraud statutes. Thus, according to Reed, even if defendant had received inside information from his father, an allegation Reed vehemently disputes, he was not legally precluded from trading on that information absent complete public disclosure. Second, Reed maintains, the Indictment fails to allege any legally cognizable injury or potential injury to Gordon Reed resulting from defendant's conduct.
In assessing the arguments of the respective parties at this phase of the litigation, it is not necessary, were it possible, for the Court precisely to identify those factors that define the concept "confidential relationship" and to determine whether such a relationship existed between defendant and his father. In the final analysis, the assessment of the existence or absence of such a relationship invariably requires a series of factual findings and generally rests with the finder of fact, i.e., the jury, at trial. Judges, charged with making the determinations of law by which to structure and evaluate those findings, may undertake this assessment only in those cases in which it is possible and proper to conclude that, as a matter of law, such a relationship does or does not exist. The very nature of the subject matter, however, reveals that such occasions will be scarce, and the instant case proves no exception. On the basis of the record as it now stands, this Court is unwilling to hold that under no reasonable construction of the allegations contained in the Indictment could no jury rationally find that defendant and his father were bound by a confidential relationship.
Nevertheless, in order to structure more meaningfully the endeavor reserved for the jury, it is necessary for the Court to discuss the sets of standards or series of considerations by which courts typically determine whether a relationship is possessed of such intimacy as to constitute a confidential relation. In declaring a relationship to be technically "confidential," the courts have emphasized a variety of factual considerations. See Bogert, supra, § 482 (and citations thereat). Chief among these factors, has been the actual placing of trust and confidence in one party by the other, which reliance has been sustained for a prolonged period. In addition, in certain types of cases, the courts generally focus on the disparity of position between the parties, "and this disparity is treated as highly important or as absolutely essential." Id. § 482 at 289 (footnote omitted). The courts are particularly wary when confronted with the interactions of those related by blood or marriage in circumstances in which the reposal of great trust and the relaxation of one's general vigilance ordinarily would be present. "However mere kinship does not of itself establish a confidential relation." Id. § 482, at 300-11 (footnote omitted). See, e.g., Francois v. Francois, 599 F.2d 1286, 1292 (3d Cir.1979), cert. denied, 444 U.S. 1021, 100 S.Ct. 679, 62 L.Ed.2d 653 (1980) (spouses); Comment, The Confidential Relationship Theory, supra, 29 Fordham L.Rev. at 564, 566.32 Rather, the existence of a confidential relationship must be determined independently of a preexisting family relationship.
As it is most frequently generalized, the common law is said to find that the clearest manifestation of a confidential relationship occurs "when confidence is reposed on one side and there is resulting superiority and influence on the other." 36A C.J.S. Fiduciary, supra, at 384 (footnote omitted). See, e.g., Francois v. Francois, supra, 599 F.2d at 1292 (quoting Yohe v. Yohe, 466 Pa. 405, 353 A.2d 417, 421 (1976)). ("confidential relation ... `arises when one party places confidence in the other with a resulting superiority and influence on the other side.'").33 A more extensive formulation incorporating this common law approach has been advanced by the courts of New York:
A fiduciary relationship is one founded on trust or confidence reposed by one person in the integrity and fidelity of another. The term is a very broad one. It is said that the relation exists, and that relief is granted in all cases in which influence has been acquired and abused, in which confidence has been reposed and betrayed. The origin of the confidence and the source of the influence are immaterial. The rule embraces both technical fiduciary relations and those informal relations which exist whenever one man trusts in and relies upon another. Out of such a relation, the law raises the rule that neither party may exert influence or pressure upon the other, take selfish advantage of his trust or deal with the subject-matter of the trust in such a way as to benefit himself or prejudice the other except in the exercise of the utmost good faith and with the full knowledge and consent of that other, business shewdness and hard bargaining being totally prohibited as between persons standing in such a relation to each other. A fiduciary relation exists when confidence is reposed on one side and there is resulting superiority and influence on the other.
Mobil Oil Corp. v. Rubenfeld, 72 Misc.2d 392, 399-400, 339 N.Y.S.2d 623, 632 (Civ.Ct. Queens County 1972), aff'd, 77 Misc.2d 962, 357 N.Y.S.2d 589 (Sup.Ct.App. Term 1974), rev'd on other grounds, 48 A.D.2d 428, 370 N.Y.S.2d 943 (2d Dep't 1975), aff'd, 40 N.Y.2d 936, 390 N.Y.S.2d 57, 358 N.E.2d 882 (1976) (franchising oil company breached fiduciary duty to franchisee by seeking to coerce franchisee to illegally fix prices and buy accessories from franchisor). See also, Quintel Corp. N.V. v. Citibank, N.A., 567 F.Supp. 1357, 1363 (S.D.N.Y. 1983) (citing Mobil Oil); Penato v. George, 52 A.D.2d 939, 942, 383 N.Y.S.2d 900, 904-05 (2d Dep't 1976), appeal dismissed, 42 N.Y.2d 908, 397 N.Y.S.2d 1004, 366 N.E.2d 1358 (1977) (same).
Recently, in reliance on the generalized expression of the common law and its formulation in Mobil Oil, the Second Circuit adopted a two-pronged analysis to assist in determining whether a confidential relationship exists in a given situation. See United States v. Margiotta, 688 F.2d 108, 122 (2d Cir.1982), cert. denied, 461 U.S. 913, 103 S.Ct. 1891-92, 77 L.Ed.2d 282 (1983). In Margiotta, a county political party leader who did not hold public office was indicted on one count of mail fraud and five counts of extortion for activities in connection with the distribution of insurance commissions or municipal properties to the defendant's political allies. The theory of liability, upheld by the Second Circuit was that the defendant's insurance "kickback" scheme fraudulently violated a fiduciary duty owed by the defendant to the citizens of the county. Since the defendant held no official public office and stood in no other inherently fiduciary position with respect to the county citizenry, it became necessary for the court of appeals to articulate the standards for determining whether a particular relationship should be accorded fiduciary status.34 In attempting to define the elements of a fiduciary or confidential relationship, an endeavor the court termed "a most difficult enterprise," the court concluded:
Although there is no precise litmus paper test, two time-tested measures of fiduciary status are helpful: (1) a reliance test, under which one may be a fiduciary when others rely upon him because of a special relationship in the government, and (2) a de facto control test, under which a person who in fact makes governmental decisions may be held to be a governmental fiduciary.
Id. at 122.35
Applying these guidelines, the court held that Margiotta's prosecution under the mail fraud statute was permissible despite the fact that he held no official public office. The circuit court observed that he "had a stranglehold on the respective governments of Nassau County and the Town of Hempstead," and that "he dominated governmental affairs [in those municipalities] as the de facto public leader." Id. In the Second Circuit's view Margiotta's conduct was reflective of the two measures of paradigmatic fiduciary relations, "the concepts of reliance, and de facto control and dominance, which are at the heart of the fiduciary relationship." Id. at 125.
Seizing upon the Margiotta guidelines and the generalized formulation of the common law, Reed argues that the sine qua non of a confidential relationship is the reposal of trust and reliance by one party to the relationship resulting in the superiority and controlling influence of the other. Reed concludes that inasmuch as the Indictment does not allege such a state of events, he may not be held to have breached a confidential relationship with his father when Reed engaged in the disputed call options transactions. Conspicuous and controlling by their absence, Reed argues, are any allegations in the Indictment that Gordon Reed relied upon defendant and that defendant thereby dominated and controlled his father's affairs. Specifically, Reed maintains, it is not alleged that Gordon Reed depended upon defendant for the operation of his personal or business affairs or that Gordon Reed was accustomed to relying upon the guidance or judgment of defendant. Similarly lacking in the Indictment are any allegations that Reed occupied a plainly superior position to that of his father such that the parties did not deal on equal terms. There is also no assertion that Gordon Reed was physically or mentally incapacitated or that he is possessed of substantially inferior business knowledge and skill than is defendant.36
Notwithstanding the absence of such allegations, the Government maintains that the Indictment sufficiently alleges facts from which the existence of a confidential relationship between Reed and his father may be inferred. In the Government's view, Gordon Reed's asserted confidence and trust in defendant as well as Gordon Reed's reliance on the alleged series of prior disclosures of and discussions with defendant created an alliance of intimacy and correlative obligations between father and son. To maintain the Indictment, the Government argues, it is not necessary to establish or even allege that Reed dominated or controlled the person or affairs of his father. Rather, the argument continues, the Government need show only that defendant was invested with a duty of fidelity and confidence by virtue of his relationship with his father. By trading on the basis of the alleged disclosures of Gordon Reed, the government concludes, defendant breached the intimacy of his relationship with his father and therefore committed securities and wire fraud.
In support of this argument, the Government relies primarily upon the discussion of the elements of confidential relationships contained in 4 G.E. Palmer, The Law of Restitution ("Palmer") §§ 19.2-19.4 (1978). Palmer theorizes that the confidential relationship conception will differ in its essentials with the circumstances it defines. Palmer distinguishes between cases in which gifts are obtained through fraud and undue influence and cases in which property, usually land, is conveyed to a grantee who promises to hold the property in trust for the grantor or some third person. In both situations courts regularly grant equitable relief if they find that the grantor and grantee enjoyed a confidential relationship. However, Palmer contends, only in the undue influence cases do the courts require some form of dominance or superiority of position as a prerequisite for finding a breach of a confidential relationship. In the cases in which property is conveyed to a grantee who orally promises to hold the property in trust for the grantor or a third person, Palmer asserts, courts generally do not — and should not — inquire as to whether the grantee was in a position to dominate the grantor. As Palmer more fully explained:
In most cases in which the court presumed undue influence because of a confidential relationship, the donor was elderly and in poor health, physically or mentally or both, and the donee was in a position to take advantage of the donor's weaknesses. Courts commonly stress the fact that the donor had no independent advice, suggesting that the relationship was such that the donor might not have made the gift had he been advised by a disinterested third party. In contrast, in cases in which a constructive trust is impressed on a grantee of land who agreed orally to hold in trust for another, and the basis of relief is breach of a confidential relationship, the grantor seldom had any of the weaknesses just described, nor did it appear that the grantee dominated him; the grantor simply trusted the grantee and believed that the relationship was such that the trust was not misplaced.
The reason for this difference in the meanings given to confidential relationship is disclosed when attention is paid to the reasons for treating the transferee as a constructive trustee. In the gift situation, the issue is whether the donee obtained the gift by a wrongful act, i.e., undue influence. The confidential relationship with which courts are concerned is one which bears on whether there was such influence. In the oral trust situation, this is not a necessary part of the case for constructive trust relief. So far as appears, the grantee usually was guilty of no wrong in accepting title to hold in trust for the grantor or a third person. His wrong occurs after the transfer and consists of his breach of the confidence reposed in him. Unjust enrichment in the first case consists of acquiring property by the equitable wrong called undue influence, in the second of retaining property by a separate equitable wrong consisting of breach of a confidential relationship.
Id. § 19.2, at 103-105 (emphasis in original) (footnotes omitted).
Consistent with this analysis, Palmer argues, if one party to a bargain transaction seeks to set aside a contract or a transfer of property on the ground that it was wrongfully acquired, courts will focus on those factors that may suggest overreaching, and in particular, whether the recipient of the benefit occupied the dominant position in the relationship. In contrast, Palmer asserts:
when information such as a trade secret is disclosed in confidence, and the defendant uses the information in breach of confidence, restitution of benefits thereby obtained does not depend on any inequality of position between the parties when the secret was disclosed since relief is not based on wrongful acquisition. Instead, the enrichment is deemed unjust because it is the product of a breach of confidence in using the secret information.
Id., § 19.2 at 106 (footnote omitted). See also, id. at § 2.8(b). Palmer maintains that although the courts have not assigned a uniform definition to the confidential relationship construct in the oral trust context, in a significant number of decisions the courts have been willing to find such a relationship despite the existence of "nothing more than a close family relationship between the parties." Id. § 19.2 at 101. In sum, Palmer concludes, "[t]aking the cases as a whole, there is a strong inclination to find a confidential relationship from the fact of a close family connection." Id. § 19.3, at 113.37
Relying on Palmer's analysis, the Government argues that the allegations in the Indictment present a sufficient basis upon which to find that Reed abused the confidential relationship that he enjoyed with his father, and thereby violated the federal securities and wire fraud statutes. By analogy to cases involving the unauthorized disclosure of trade secrets, see, infra at 37, the Government urges that even if this Court is unwilling to find that a confidential relationship existed solely because of the kinship of the Reeds, such a relationship can be premised on the duty of confidentiality that accompanied Gordon Reed's disclosure of the Socal merger proposal to defendant. Thus, the Government concludes, when Reed traded on the basis of the information revealed to him by his father, Reed breached the duty of fidelity and confidence that had induced his father to make disclosures at the outset.
In assessing the sufficiency of the Indictment, the parties would require this Court to choose between two petrified formulations of the meaning and scope of the concept "confidential relationship." The Court's endeavor, however, is not so limited. Instead, the Court concludes that in attempting to depict this concept in a fashion favorable to their respective points-of-view, each side has presented only a part of the picture. In a general sense, the term fiduciary or confidential relationship connotes a relation of trust as the basis of obligation and corresponding reliance or security. Such reliance may be either experienced unilaterally by one of the parties to the relationship or shared mutually by both members. A confidential relationship is based on the reposal of trust and confidence and envelopes both technical fiduciary relations as well as those informal alliances that arise whenever one person trusts in, and relies upon, another. The confidential relationship concept thus has reference to any relationship of blood, business friendship, or association in which the parties repose special confidence in each other and are in a position to have and exercise, or actually have and exercise influence over each other.
Beyond such generalities, what constitutes or defines a confidential relationship is frequently the subject of controversy. The relationship may exist under a great variety of circumstances, and purposely has been formulated ambiguously to embrace a myriad of situations. Consequently, save for its essence of fidelity and confidentiality, the articulating characteristics of such a relationship and the prerequisites to its formulation must vary with the situations that the relationship simultaneously reflects and governs. See 36A Fiduciary, supra, at 385.38
Despite the seeming boundlessness of the confidential relationship construct, certain paradigmatic scenarios have emerged. As the cases reveal, a confidential relationship will be found to exist in those circumstances in which special confidence has been reposed in one who, in equity and good conscience, is bound to act in good faith and with due regard to the interests of the one investing the confidence. Similarly, it is fundamental that courts will find a confidential relationship in cases in which confidence is reposed on one side and there emerges a resulting superiority and influence on the other. See cases cited supra notes 32, 33, 37. Nevertheless, it is a mistake to attempt to distill from these situations general and unyielding principles by which to identify a confidential relationship no matter how diverse the context. For it is equally well settled that the existence vel non of such a relationship is ultimately a question of fact, the resolution of which rests on the particulars of the interactions between the parties and the texture of their specific relationship. See cases cited supra notes 32, 33, 37.
For this reason, the Court must reject, as have the commentators, defendant's argument that he could not be held to have been engaged in a confidential relationship with his father in the absence of proof that he dominated or controlled his father. This argument rests on just such an attempt to derive a rigidified definition of the confidential relationship construct from specific cases. To support his argument, defendant relies upon cases in which courts primarily exercised their powers in equity to set aside completed transactions on the ground that a disputed benefit was wrongfully obtained by means of fraud or undue influence. In this setting, the commentators explain, the courts necessarily focus on the relative equality of the parties' positions, as well as on the degree of influence or dominance that the benefiting party could or did exercise over the other. See, e.g., Palmer, supra, § 19.2, at 102-03, 106; Bogert, Confidential Relations, supra, 13 Cornell L.Q. at 246-47. In other circumstances, as for example, in the oral trust situations, the issue of dominance or inequality of the parties is not controlling, and the circumstances may favor finding a confidential relationship even when the positions of the parties approach equilibrium. See, e.g., Palmer, supra, § 19.2, at 102-03, 106; Bogert, Confidential Relations, supra, 13 Cornell L.Q. at 246-47.
In analogizing the confidential relationship concept to that of a quasi-trust, Professor Bogert requires that "[t]he trust and confidence imposed by a quasi-cestui in a true confidential relation must be an extraordinary reliance which causes the quasi-cestui to drop his guard, abandon formalities, and deal with another in intimacy." Bogert, Confidential Relations, supra, 13 Cornell L.Q. at 245. Defendant's argument that Professor Bogert would not declare a confidential relationship to exist in the absence of dominance or superiority of influence by one of the parties is based on a misreading of that commentator's views. In an influential law review article, Bogert states expressly that dominance is not a prerequisite to a finding of a confidential relationship in all circumstances. Nevertheless, he explains, superiority of influence on behalf of the trusted party will necessarily result from the genesis of such a relationship. Rather than the eternal precondition of all confidential relationships, dominance or superiority of influence remains the ever-present byproduct of such associations. In Bogert's analysis, a distinction must be drawn between those elements that reveal the existence of a confidential relationship and those that would justify a court's setting aside a transaction on the grounds of undue influence or overreaching. He explains:
Dominance is not necessary to the origin of a trust and it should not be a prerequisite to the rise of the quasi-trust or confidential relation. It is not required in order to have an express trust that the trustee should tower over the cestui in physical, mental, or moral qualities. They may be on a parity. It is believed that the conception, previously referred to, that there can be no confidential relation without dominance or superiority of position, is due to confusion of thought. The mere fact that A is ignorant and inexperienced, and B educated and skilled in affairs, does not tend to prove that A and B are in a confidential relation. A may have trusted B and given B influence in A's affairs or he may not. If there has been such trust extended and influence acquired, it is immaterial whether the parties were equal or unequal as far as the existence of the confidential relation is concerned. But the disparity is important for another reason. It is evidence from which a finding of undue influence would be justified. If an aged, feeble, ignorant man conveys to an able-bodied, experienced business man, under an oral trust, a court may well treat the facts of disparity and the conveyance as some evidence of actual undue influence, or as raising a presumption of undue influence, or as creating a duty on the grantee to introduce evidence to show good faith, full disclosure and a fair price. But it is a misnomer to use "confidential relation" to describe the dominant character of the stronger. The stronger may have been trusted so as to come into a confidential relation, but the mere dominance does not show the trusting. There seems to have been a confusion of the quasi-trust and undue influence concepts at this point.
In arguing that dominance is not a relevant factor in determining the existence of a confidential relation, the writer does not wish to be understood as stating that, after a confidential relation has been created, superiority of influence on the side of the confidante is not a necessary result. Such superiority is an effect or consequence of the confidential relation, and not a cause of the origin of the confidential relation.
Bogert, Confidential Relations, supra, 13 Cornell L.Q. at 246-47 (emphasis in original).
Bogert's analysis was echoed half-a-century later by Professor Palmer, who concludes that the meaning and requisites of a confidential relationship in the oral trust context differ from those in situations of undue influence.
In the latter instance the relief sought is rescission of the gift on the ground that it was obtained by a wrongful act. The presence of a confidential relationship is important only as it bears upon the issue of undue influence, and for this purpose it is important that the donee occupied the dominant position in the relationship. When a donee receives a gift for his benefit, he may well be in a confidential relationship with the donor, but that alone provides no reason for rescission of the gift. In contrast, if a grantor conveys land to a person who agrees orally to hold in trust for the grantor, the relevance of a confidential relationship between them is that it is inequitable for the grantee to retain title to the land through failure to perform his duty; hence, he holds the land as constructive trustee for the grantor. It is not necessary that the grantee be the dominant party to the relationship. In the one case the donor is awarded restitution of a gift he intended for the donee because the latter obtained it by wrongful conduct. In the other case there was no wrongful acquisition from the grantor; a gift to the grantee was not intended since he was to hold in trust for the grantor, and the latter obtains restitution because of a wrongful retention of the title.
Palmer, supra, § 19.3, at 108-09 (emphasis in original). See also id. § 19.2, at 103-05.
Consistent with this analysis is the judicial treatment of the confidential relationship concept in situations in which information such as a trade secret is disclosed in confidence and then used for personal advantage by the recipient of that information in breach of such confidence. In these circumstances, the courts regularly consider the parties to be bound by a confidential relationship, and hold that the unauthorized use by the entrusted party of this information violates that relationship. See, e.g., E.I. Du Pont De Nemours Powder Co. v. Masland, 244 U.S. 100, 102, 37 S.Ct. 575, 61 L.Ed. 1016 (1917).39
The decision of the Second Circuit in Schreyer v. Casco Products Corp., 190 F.2d 921 (2d Cir.1951), cert. denied, 342 U.S. 913, 72 S.Ct. 360, 96 L.Ed. 683 (1952) is illustrative. In that case, the plaintiff after applying for a patent on an electric steam iron entered into negotiations with representatives of the defendant in an attempt to license the manufacture and sale by the defendant of the plaintiff's iron. During these negotiations, the plaintiff gave to the defendant blueprints and other detailed information about the construction and manufacture of the iron. The complaint alleged, and the trial court found, that the defendant then used this information to its own advantage without concluding a deal with the plaintiff. On the basis of these facts, the Second Circuit held:
Although the court found no express agreement to hold the information in confidence and not to use it if the negotiations for a license were not successful, there was a confidential relationship created between the parties by the disclosures which restricted the right of Casco to use them to the purposes for which the disclosures were made. Hoeltke v. C.M. Kemp Mfg. Co., 4 Cir., 80 F.2d 912. The breach of this confidential relationship, enabling Casco to invade the plaintiffs' market, was unfair competition.
Id. at 924.